All,
When looking to acquire or develop/re-develop a property, do you look to see if being energy-efficient is going to lead higher value rather than trying to reduce costs?
Other follow-up questions that may help answer the main question:
• If it does help drive value, how is sustainability quantified?
• Is there anything other than LEED certification? Does this measure or other measures help drive value?
• How does the real estate industry think about sustainability? Is it the first thing comes into mind?
Looking forward to hearing your answers. Thanks much.
Update to OP: This thread originated from the fact that sustainability is becoming a real issue or has been for the past several years. There are organizations that are asking companies (be it large fixed income asset managers of RE funds) what are they doing to be more sustainable.
I assume you're asking because this is the question the professor posed as weekly homework?
The obvious answer is that cost reduction directly leads to higher value, since your terminal value is based off of your NOI.
If the question is whether users of the space value sustainability, then the answer will be very fragmented and end-user specific. Some do, some don't. Being LEED generally won't hurt your value, but a condo buyer might not want low-flow shower heads, so maybe in specific instances it will.
Being energy efficient can be a plus when approaching municipal authorities. It certainly can help in the case of natural disasters. But those are hard to quantify, either because it's a qualitative political concern like the former, or just rare and unpredictable like the latter.
I suggest you think about the product your "looking" at and the market it is supposed to be in and go from there. Solar powered, water efficient buildings in Arizona might be hugely valuable, and an easy sell when looking for entitlements from a housing agency. Passive house might be more valuable in storm-prone areas like the Gulf Coast, where an entire building can be heated/cooled on a small generator in the case of a power outage. Super dependent
To build on this, I would say it builds value in three cases: 1--to the extent it lowers operating expenses and drives NOI 2--to the extent it helps minimize strain on building systems, reducing the long term horizon for capex dollars 3--specifically for office, some of the best credit tenants in the market will specifically target LEED Gold/Platinum assets for office space as a PR move. A lot of the oil companies (BP, Shell) are ironically in the most sustainable office buildings in the DC market so they can beat their chests about how they support the environment. Oil company tenant = top of market rents, AAA credit.
The above is spot on. As a rule (with maybe some very individualized exceptions), an investor is not going to pay 1 penny more than the intrinsic value of the cash flows (what he/she determines is the intrinsic value, which is always a bit subjective), if for no other reason than the fact that their lender won't attribute to them any value above intrinsic economic value.
Kind of as a telling anecdote, I pitched to a group of (equity) investors the idea of building right-sized single-family homes--houses that would be affordable and desirable for the middle class buyer by being size and space efficient; they would be standardized to ensure that buyers would never be up-sold into buying stuff they didn't really need (and would almost certainly regret having to pay for later). The group of investors did not care about the social mission at all (building affordable housing for the missing middle)--in fact, I was criticized for leaving the fattest part of the profit--the buyer options--off the table.
Investors just don't care. They want to make money. You have to show them why LEED, right-sized homes, etc.--can boost the bottom line (like the example given above--top office tenants would be more attracted to the property). I failed to show that for my idea--the investors told me to pound sand.
To be fair, this doesn't apply equally to all investors - there are plenty of dollars floating around that are specifically looking to attach to a deal with a socially responsible mission statement, or environmentally sound, etc. But speaking broadly, yeah, the average investor cares about $$$ first, second, and third, and only at the bottom of the list comes to qualitative social good.
If you were to re-pitch to those same group of investors again, how would have you shown LEED is the way to go to reduce operating costs or reduce future capex?
Are there any comps that keep track of this?
For my pitch specifically, environmental soundness/LEED was not really part of the pitch--it was really about targeting a missing demographic--the middle class, which is getting priced out of many markets.
To be honest, I haven't figured out a good pitch yet. The reality that I can't get around is that it is much, much more profitable to build large houses and to push buyer options (because there is usually about a 50% profit margin in buyer options--though I've come to the conclusion that this is borderline unethical for a number of reasons I won't get into). I think the only way I could really sell the idea--and I'm open to ideas--is if I can show a way to build at huge volume (1,000+ units) per year. If you only make $50,000/unit but can somehow put out 50,000 units in a year, you'll be a billionaire in no time flat, right? Right?! RIGHT?!!!
Very interesting thread. I'm currently writing a paper at my current company on a similar, albeit different topic. I can't go too far into the details as the goal is to get it published. It's not so much the environmental (solar, LEED, etc.) as physical destruction post-disaster. Look what just happened to Houston, Florida, Puerto Rico...
At what point does this destruction in vulnerable (but popular cities) hinder the sale of an asset? Is there a threshold for investors to say: "No, this building is going to flood and get demolished."?
As a side note: in my research I've started to see that financing is getting harder to come by to a certain degree specifically related to this reason. I still have a lot more research to do on that front, but has anyone else heard the same thing? Not sure if it's related to engineering/architectural plans, etc. but I'm very curious to see what's happening now and what the trend will be.
I don't operate in any of these markets, but in theory this should be priced into the deal. Not hard to come up with insurance costs, and any buyer is going to price the cost of insuring a building into their model. You're already compensating for this in your NOI. I imagine flood insurance in Florida is more expensive than in Denver.
This is sort of the point I was making to the OP. There are lots of smart people in every corner of this industry and most of these costs have been quantified.
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